Canadian Law Embraces Duty of Honesty in Contractual Performance

Parties to contracts in Canada now have a very good reason not to lie or act deceptively to their counterparties in performing their contractual obligations: it is now the law. In a highly anticipated decision released last week, Bhasin v. Hrynew (Bhasin), the Supreme Court of Canada held that Canadian contract law would now recognize a general organizing principle of good faith performance, as well as a specific duty of honest performance applicable to all contracts in Canada. The decision—described by the Court as an effort to make Canadian contract law more settled, more just, and more in tune with the reasonable expectations of commercial parties—has immediate implications for Canadian businesses, most notably in creating certain minimum standards of conduct for contractual performance.

Background

The Bhasin case was a dispute relating to a renewal clause in a contract between an Alberta-based company which marketed education savings plans (ESPs) to investors, and one of its retail agents, an individual who, under the contract, sold the ESPs on behalf of the company in exchange for compensation and bonuses. The company ultimately exercised its right not to renew the contract near the end of its three-year term, but the evidence was that, in exercising that right, the company had dealt dishonestly with the plaintiff, and even lied to him. In particular, the company had misled the plaintiff about plans it had to merge his agency with a competing agency, which it favoured over his agency, and certain measures it was taking to have the plaintiff’s agency audited by the principal of the competing agency. Ultimately, the plaintiff’s objections to the company’s efforts to merge his agency with the competing agency and allow the competing agency to audit his records led to the company threatening and then exercising the non-renewal option. The non-renewal caused the plaintiff to lose the value of the business he had built under the contract, and resulted in most of his sales agents moving to the competing agency.

The trial judge concluded, and the Supreme Court agreed, that the company had acted dishonestly and in bad faith with the plaintiff throughout the period leading up to its exercise of the non-renewal clause. But the question before the Supreme Court was whether the defendant owed the plaintiff a duty of good faith in the first place, and whether that duty had been breached.

The Decision

In a unanimous decision written by Justice Cromwell, the Court began its analysis by observing that Canadian courts (outside of Québec) had generally resisted acknowledging any generalized and independent doctrine of good faith performance of contracts, primarily out of concern that such a doctrine would create commercial uncertainty and undermine freedom of contract. The Court noted that this historical reluctance to recognize such a doctrine, coupled with sporadic attempts to carve out a limited role for good faith in certain contexts, had resulted in an unsettled and incoherent body of law that was difficult to analyze. It also noted that the reluctance to recognize an obligation of basic honesty—which was out of step with the law in the United States as well as in Québec—was out of touch with commercial parties’ reasonable expectations, as no reasonable commercial party would accept a contract that allowed dishonesty in performance.

It was time, the Court decided, to make the law more certain, more coherent and more consistent with the reasonable expectations of commercial parties, by taking two "incremental steps."

Good faith as a general organizing principle

The first step the Court took was to recognize that there is an "organizing principle" of good faith that underlies and manifests itself in various specific doctrines governing contractual performance. That organizing principle, as the Court put it, is simply that parties generally must perform their contractual duties honestly and reasonably, and not capriciously or arbitrarily. The Court explained that the organizing principle exemplifies the notion that a contracting party should have "appropriate regard to the legitimate contractual interests of the contracting partner" —with "appropriate regard" varying depending on the context of the contractual relationship, but at a minimum requiring that a party not seek to undermine the other party’s interests in bad faith.

The Court emphasized that the organizing principle of good faith is not itself a free-standing rule (and is therefore not itself enforceable). Rather, it is merely a principle that underpins and manifests itself in specific legal doctrines which are enforceable—such as the existing doctrines in certain areas of the law (like employment, franchise and insurance law) that require honest, candid, forthright or reasonable contractual performance. The Court stated that, generally, claims of good faith will not succeed if they do not fall within those existing doctrines (and in this respect, the Court’s first step was incremental indeed). But the Court recognized that the list of doctrines that could manifest the organizing principle of good faith is not closed—and its second incremental step, described below, illustrated how the organizing principle could be used to create a new doctrine.

Duty of honest contractual performance

The second, and more significant and consequential, aspect of the Court’s decision in Bhasin was to use the organizing principle of good faith contractual performance to create a new duty of honesty in contractual performance. The Court stated that this duty, which applies to all contracts, requires that parties "must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract." It stressed that the duty should not be confused with a duty of disclosure or of loyalty, and that a party to a contract has no general duty to subordinate his or her interests to that of the other party. It imposes only "a minimum standard of honest contractual performance."

The Court further held that, as a general doctrine of contract law that applies to all contracts, the duty of honesty in contractual performance cannot be excluded by agreement of the parties. However, the Court indicated that parties could, by agreement, "influence" the scope of honest performance in a particular context, so long as they respected the minimum core requirements of the duty. The Court stressed that any modification of the duty of honest performance would need to be in express terms.

Implications

The Supreme Court’s recognition of a general duty of basic honesty may indeed be a "modest, incremental" step as far as the law is concerned. But for businesses, whose day-to-day operations revolve around the performance of contracts, the recognition of the duty of honesty has major ramifications—even where honesty has already been the policy. Indeed, with the imposition of a new legal duty that creates the potential for new legal liability in respect of any aspect of contractual performance, parties engaged in business in Canada will need to carefully review their existing contracts to ensure that their conduct and policies in respect of all aspects of those contracts are in line with the new minimum standards of conduct imposed in Bhasin. In particular, careful consideration will need to be given to the manner and context of contractual performance, any circumstances that could be taken to reflect dishonest or deceptive conduct, and communications (both external and internal) pertaining to matters that could give rise to a dispute.

Historically, the recognition of a new legal obligation in business law has spurred a notable increase in litigation, and that will almost certainly be the case in the wake of Bhasin, particularly given its applicability to all contracts. Future litigation concerning the duty of honesty will also likely be routinely complex, raising issues not only about what a party did, but why and how the party did it. Difficult questions will arise about the scope of appropriate discovery in such cases.

To minimize the risk of being caught up in this potential flurry of litigation, businesses may wish to take the Supreme Court’s (somewhat tentative) cue to expressly define in their contracts what honest performance requires in specific contexts. However, given the minimal requirements of the duty of honesty and the rule that those basic requirements cannot be excluded by agreement, it is unlikely that any such terms would be necessary or be of any use in the event of a dispute. At the end of the day, honesty in contractual performance will likely not be determined by contractual terms, but rather by the same objective standards by which the concept is generally understood.